Market to feast on every crumb in reporting season

Matthew Kidman

REPORTING season is a fertile time to make money from trading. Companies that beat consensus earnings forecasts and give positive outlook statements will outperform in the short term. Companies that miss their numbers or cast a shadow over future earnings will typically underperform.

Since last earnings season, the All Ordinaries Index has climbed 15 per cent. Back then, sentiment was grim, with most analysts sharpening their pencils to downgrade earnings. Companies only needed to hit guidance to trigger relief rallies in their share prices. Within the space of six months, expectations have become grander and companies will need to beat estimates and the outlook commentary will have to have a silver lining. Companies that miss their numbers could be punished.

Since Christmas a string of companies have announced strong earnings revisions prior to reporting their numbers. These include retailer Specialty Fashion, car dealer AP Eagers, engineering outfit E&A Limited, and debt collector Collection House. All have had strong share price performance before and after the updates.

E&A Ltd (EAL)

WE WROTE about E&A in November when it announced its September quarter update. The stock had become friendless, but rising earnings together with a hefty dividend yield got some people excited. At the time the company was trading around 32¢. If you annualised the first-quarter net profit of $1.6 million, the company was trading on a modest price to earnings (PE) ratio of 5.6 times and a dividend yield of about 12 per cent. At the time we said the stock had the ability to jump to 45¢. E&A's share price has eclipsed that target and now trades at 54¢.

Last week, the company announced its second quarter was an improvement on the first-quarter net profit of $1.6 million. If we assume E&A can deliver a net profit of $2 million for the second quarter, then it is on track to hit a full-year profit of $7.2 million, placing it on a PE ratio of eight times and a dividend yield of 8 per cent.

If the commentary at the half-year result next week confirms the earnings momentum, it is feasible the stock can trade 20 per cent higher to 65¢ a share as its dividend payment gets closer.

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Devine Ltd (DVN)

THE Queensland-based property group has been charging higher in recent weeks. There have been reports that the south-east Queensland housing market has started to pick up after a four-year lull. Devine's shares have gained a remarkable 60 per cent since early November. Despite this spurt, Devine continues to trade at less than half its asset backing of just shy of $2 a share. Given the high debt levels and the prospects of a capital raising, it is unlikely the stock can trade at asset backing. But the share price should climb if the property market continues to improve.

In November, the company delivered a disappointing net-profit forecast of just $10 million for the 2013 financial year. Shareholders will be hoping chief executive David Keir will indicate that interest rate cuts are having an effect and the outlook is improving. Such comments would propel the share price towards $1.40. Sombre commentary would be a setback for the rallying stock.

Sydney Airport (SYD)

A DECISION by the Tax Office to release a position paper questioning the tax deductibility of the airport's redeemable preference shares has led to a fall in the stock from $3.61 at Christmas to $3.04 on January 18. Since then the shares have recovered to be trading around $3.15. Sydney Airport, riding on a strong yield, had been a star performer until December, outperforming the ASX/S&P 200 Index by about 25 per cent in 2012.

The lion's share of the selling since Christmas has come from offshore investors who are concerned the bigger tax bill will result in a reduced distribution - currently around 7 per cent.

The Tax Office has only targeted $900 million of a possible $3.1 billion RPS and there are fears the view will extend to the whole amount, further reducing the after-tax income. While foreign investors are upset, the extra tax paid would increase franking levels, inducing local shareholders onto the register.

If the ATO wins the day, the company always has the ability to restructure its capital.